Inside The Koch Empire: How The Brothers Plan To Reshape America

Daniel Fisher
,
Forbes Staff
I cover finance, the law, and how the two interact.

This story appears in the December 24, 2012 issue of Forbes.
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Continued from page 2

Charles Koch

Koch executives also had to devise a marketing plan to compete with Procter & Gamble and Kimberly-Clark, each with generations of consumer marketing experience. That's still a work in progress--Koch had little experience selling brand-name products in retail stores--but something managers have been encouraged to spend money on and master.

The timing for all this investment couldn't have been lousier. Just as the company began to revamp its paper towel and toilet paper businesses, the financial crisis and housing market collapse devastated Georgia-Pacific's building-products division. No matter. The Koch long-game strategy is absolute: If it makes sense to them, the Kochs stay with the plan, no matter how burdensome or how long it takes. "We buy something not to milk it but to build it, to take its capabilities and add to them, and build new businesses," Koch says.

Five years into the deal that strategy was easy to fault. Seven years in it's looking smart: This $21 billion purchase, factoring in the debt, is now worth some 30% more, FORBES estimates. "Charles is always asking, 'Where can you take on more profitable risk?'" says Steve Daley, Koch's in-house Market Based Management enforcer. "Playing it safe is slow suicide."

Hayek isn't the only political philosopher to dramatically shape the Kochs. The brothers' hatred of centralized controls stems as much from Stalin as it does from Hayek, a feeling largely inherited from their father, Fred, the son of a Dutch immigrant who settled in tiny Quanah, Tex. near the Oklahoma state line in 1891. Fred Koch studied chemical engineering at MIT and worked for the Soviet Union after big oil companies drove his U.S. refinery-engineering firm to the brink of bankruptcy with patent litigation in the early 1930s. In the U.S.S.R. the elder Koch made a fortune building refineries for Stalin--but developed a visceral disgust for communism in general, and for his benefactor in particular, after his Russian associates were executed in purges.

Fred returned to the U.S. on the eve of World War II and built an even larger fortune around Rock Island Refining, a refinery and oil-gathering pipeline system in southern Oklahoma, and a part-interest in a refinery outside of Minneapolis. Fred was also an early supporter of the virulently anticommunist John Birch Society, founded in 1958.

Fred's four sons--Charles, David, Bill (David's twin) and Frederick, the oldest --grew up on his family's quarter-section (160 acres) of land outside Wichita. Charles recalls his father working him from dawn to dusk on the property, while he could hear his friends playing golf and tennis at the nearby country club. "He had me work, because if I didn't, I'd get in some sort of trouble," Charles now says. (Charles showed similar strictness toward his own son Charles, known as Chase, now 35 and a Koch Industries executive. When Chase, a nationally ranked tennis player, seemed to be dogging it on the court, Charles gave him a choice of putting more effort into his game or getting a job. Chase chose the job and was dispatched to a Koch-owned cattle feedlot in western Kansas for the rest of the summer.)

Charles followed his father to MIT, as did David and Bill, eventually earning master's degrees in chemical and nuclear engineering and going to work for the pioneering consulting firm of Arthur D. Little. But his father, suffering from advanced heart disease, kept pestering him to return to Wichita and run the business. At that point the refining business was earning about $1.8 million a year on sales of $68 million (much of it low-margin oil pipeline revenue) and the engineering business was breaking even on about $2 million a year.

Fred gave his son the refinery-engineering business to run with a simple command: "You can run it any way you want, but you can't sell it."

Charles quickly realized short-term thinking was holding the business back. His father was obsessed with conserving cash to pay estate taxes, and managers were losing business because they refused to share design data about their refinery equipment. "Standard Oil of New Jersey isn't going to buy stuff unless they understand it," Koch recalls saying.

He saw the business could grow much bigger and, in a pattern he has maintained to this day, steered the firm's slender earnings into projects like a new factory in Europe. "I didn't care about living high on the hog," says Charles, who like Buffett lives in an unpretentious house, constructed on his family's property in 1975. "I wanted to build something."